CIBC says brokers' estimates too low

GregMorcroft

NEW YORK (MarketWatch) -- Analysts at CIBC on Thursday initiated coverage of the brokerage sector and said the biggest firms in the group are likely to report earnings as much as 20% above current estimates and sounded bullish tones for the short and long terms.

"We initiate coverage of the large-cap brokers with an Overweight sector Stance...based upon both near- and long-term themes. We believe that fixed income, equity, and M&A will all achieve record years, and as a result believe that EPS will be 15%-20% higher than current estimates," the analysts said.

"Structurally, the brokers have increasingly disintermediated the banks and rendered the traditional bank model increasingly irrelevant. Accordingly, we believe the valuation gap between banks and brokers will close in the brokers' favor," the analysts said.

Fixed income has changed, for the better

CIBC researchers said results for the last several years have proved that the nature of the fixed-income business has changed as demand continues to outstrip supply.

They said the recent, persistent low long-term rates and the currently inverted yield curve support that thesis.

The yield curve is inverted when long-term interest rates have lower yields than short-term interest rates, and is traditionally interpreted as a sign of possible looming recession or an indication rates are expected to fall.

"To suggest that the brokers, the most innovative financial minds in the world, will be unable to create and supply compelling yield product to match what is now an unbalanced demand/supply equation is simply naïve, in our opinion," the analysts wrote in the report for clients.

The analysts suggested that growth in overseas debt issuance also supports their investment thesis for the brokerage sector. They said while U.S. debt market issuance has risen during 8 of the last 10 years, overseas growth has outperformed, rising in 9 of the last 10 years.

Combined, those factors will likely produce another bullish year in the fixed-income business for the sector, the report concluded.

"We believe at the very least, market share gains in the growing European debt markets will more than offset a possible decline in U.S. mortgage volumes," they said.

Bullish on equities too

The report reflected the researchers' conclusions that 2006 would be a good year for the equities business. It reiterated recent broader evidence that individual investors are back as an active force in the market after several shaky years following the Internet bubble bursting and subsequent market shakeout.

Analysts said their premise is that "business attracts business" and investors put cash where it earns the most. With long-term interest rates unrewarding and the S&P yielding 2% currently, with a 3%-plus return so far in 2006, stocks are more attractive.

They said a potential return for equities of about 5% this year will lure individuals back into the stock market particularly now that house values are falling.

And, the analysts estimated as much as $1 trillion currently held in time-deposit accounts could move in the equity markets this year.

"At a minimum, we think it is safe to assume that housing prices have stopped going up materially. Whereas we believe most individuals have counted their expanding equity through their rising home value into their net savings calculation, as that abates we believe individuals will return to the investment that offers the most compelling returns," the report concluded.

The third leg of the stool

Rounding out the analysts' bullish stance, the said strong merger and acquisitions activity will continue to drive revenue and profits for the brokers as well.

They argued that the biggest cash positions in 25 years at American firms combined with growing amounts of money going into private equity funds is likely to create a corporate shopping spree. That activity should make 2006 a record year for M&A, the analysts said.

"Given our bullish thesis on all three drivers of broker revenues, we find it impossible to imagine that earnings for the group will only be higher for the year by 5%, as measured by First Call consensus estimates," the report said.

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